Our INTERVIEW OF THE WEEK this week is with one of the most successful Founder-CEOs in the history of the online industry: Reed Hastings of Netflix.

In the past decade, Reed has built Netflix from a little DVD-by-mail company into an international behemoth with a $12 billion market cap that is disrupting the traditional TV distribution business.

Along the way, Netflix's surging stock price has made fools (and paupers) of no end of skeptics.

What's next for Netflix? Will the skeptics finally be right? Or will the company's second decade be even more impressive than its first?

SAI's Dan Frommer and Henry Blodget spent a half-hour on the phone with Reed last week discussing the following topics...

The size of Netflix's market opportunity (bigger than you think)

"Personalized" Netflix accounts (one for every person in the family)

The competition

Why Netflix isn't offering pay-per-view

Whether Netflix will offer "tiered" streaming prices

Whether content companies will screw Netflix in the next round of negotiations

Whether the cable cos will try to crush Netflix by enacting bandwidth caps

The three key aspects of Netflix's culture that have helped it become such a success

Whether Reed will be running Netflix for the next 10 years

And more...

Enjoy!

(And thanks to Business Insider's Ellis Hamburger for transcribing the call.)

Henry Blodget: Welcome, Reed! Thanks for doing this. Ten years ago, I remember when Netflix was originally thinking of going public, you were a tiny DVD-by-mail business, and everybody smart I talked to said there’s no chance in hell this thing ever works. Here we are ten years later, 20 million subscribers, two billion in revenue, 12 billion dollar market cap. Where do you think you’ll be ten years from now?

Reed Hastings: Well sticking with ten years ago, we couldn’t even get a meeting with you. (Laughs) Anyway, where are we in ten years? I don’t know, I couldn’t have predicted where we are from then.

BI: So it’s bigger than you thought it might’ve been?

RH: Oh, bigger and different. We were back in 2001. We were not yet profitable. We were growing on DVD and wondering how things will work. There are a lot of differences.

BI: Well, let's look forward 10 years. Do you think you’ll still be running the company?

RH: Ten years is always too long to make any useful prediction.

BI: But that’s your ambition? You’re not ready to hang up the skates?

RH: I can certainly say that I’m not thinking of retirement this year, but ten years for anyone, it can depend on so many things.

BI: Okay, let's talk about your market opportunity. You have 20 million subscribers now, approximately, in the United States, and there are something like 115 million households now. When you think about the total market opportunity domestically, what should people think is a reasonable number of subscribers that services like Netflix ultimately will have?

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RH: The way we look at it is on the upper bound, we do it by mobile phone subscriptions, the number of people in the United States that pay for a mobile phone. That cuts out very young kids, people with zero income, and that number is about 300 million.

BI: Our household only has one Netflix subscription. We currently pay you a lot more than eight dollars per month, but I don’t envision a scenario where my wife has one account and I have one account and each of my kids have an account, so you really think that that’s a reasonable way of looking at it?

RH: No, that's the upper bound. So the upper bound, if it was natural for each family member to have a separate subscription, like you each have a separate Facebook account, if it becomes so personalized video that you do want it individualized, than that would be the upper bound. Another way of looking at the market is the number of households that can subscribe to cable or satellite, and that number is about 100 million.

BI: Do you think that you ultimately will start offering personalized accounts? That’s an interesting idea that I hadn’t heard before.

RH: It’s quite personalized now, but not in a way that’s so compelling that you never want to say “I don’t want to use my kid’s account.” The question is, over time, can we make Netflix so personalized that as the kids get to be teenagers and they get their own Facebook account and their own mobile phone, that they also get their own Netflix account?

BI: Do you think that that’s likely?

RH: No, it’s a possibility. It’s an aspiration.

BI: So, as you think about it, do you think the 100 million number is the right market-opportunity number that people should think about, or should it be a 200-300 million type number?

RH: Well 100 million is another upper bound, and that assumes, in this case, that every single cable or satellite household subscribes to Netflix, so both of those are available market figures. As to how they get split between Netflix and its competitors, that’s really hard to tell. Somewhere north of 20 million, south of 300 million.

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BI: What percentage of the 20 million now have cancelled cable or other TV?

RH: Everyone, essentially, on Netflix has a TV service and also 30% of them have HBO, which is the national average.

BI: So right now, it’s definitely not an either/or, in fact it’s just how many more services can you pile on top of your existing cable service?

RH: Yes, that’s right. We’re like one more cable network. We’ve grown from in the last three years, the number of streaming accounts in the US from zero to 20 million, and MVPD (multi-channel video programming distributor) is basically steady, so last year, total MVPD in the US went down slightly, or the first three quarters of the year, but that was largely due to the recession. And then in Q4, total MVPD households went back up. And if Netflix were a substitute, you would see MVPD going down like landlines have, or something like that, which you don’t see.

BI: We already talked about one possible way that you could get more money per household, which is personalized accounts. Do you think that with streaming, you will ultimately have tiers, the same way that you do with DVDs. Like I get a basic selection for $8, but if I pay $15 I get twice as much stuff, or I get cooler, different stuff. Or if I pay $50, I get everything?

RH: We don’t have any plans for that. We want to focus on a simple proposition: unlimited streaming for $7.99 per month. Our big focus is taking that simple proposition around the globe. We started with Canada seven months ago, we’ve been super successful there, we’re targeting to surpass 1 million subscribers this summer. Less than one year from launch in Canada. That’s been so successful that we’re now expanding to other countries.

BI: What other markets are attractive?

RH: All the markets where people have broadband and like TV.

BI: Must be a tiny opportunity.

RH: Exactly.

NEXT: Netflix's upcoming content negotiations...

BI: Switching gears, let's talk about content deals going forward. I know Time Warner CEO Jeff Bewkes was quoted recently as saying something like “Look, back when Starz did their huge deal with Netflix, they were asleep at the switch, it was just a test, and suddenly, everyone has now woken up. There’s no way anyone would ever cut a deal like that again.” Do you think that’s true?

RH: When we did the Starz deal in 2008, we almost walked away from it because it was so much money for an activity that basically didn’t happen, i.e. streaming, at the time. Now, as we look at renewal coming up the middle of Q1 next year, we will clearly pay more. And there are more people streaming, so we can afford to pay more.

BI: Do you think you’ll pay the same way? As I understand it, the last deal was basically a flat fee--will the next deal be a per-sub fee, or is it likely to be per-stream? How do you think the content deals of the future like that will be structured?

RH: I’m not really sure. We’re looking about how to acquire content. Traditionally or generally, most of our content, they want a guarantee, and a flat rate.

BI: They want that even with you going from however many single-digit million subscribers you had when you started the Starz deal to now, with 20 million subscribers, even going forward you think they’ll want that, or will they want an average fee per sub or per stream?

RH: Many of our deals are shorter term, 1-2 year deals, so it’s fixed in the short term, but fundamentally it’s variable in the long term.

BI: You’ve said you ultimately hope to be the biggest revenue source for a lot of the content providers. The objection that I hear raised to that very quickly is “Oh come on, look how much the cable companies pay, that’s why the bills are $160 per month, Netflix is $8, how could that possibly be?” What’s your reaction to that?

RH: For some content owners like Relativity Media, where we did an output deal with them, we’re already their biggest customer. So it depends on the content, in terms of the big bill that you referred to. There’s a huge amount of sports content, a majority of the value of MVPD. And then of course there’s news and reality and lots of other content types that we don’t focus on.

BI: Do you think you ever will offer news and reality and other types of content? I know I read a presentation a couple of years ago from you saying “No, we’ve picked our market, we’re going to focus on that market.” I know a lot of subscribers hope that you’ll go into sports and things like that. Is that possible?

RH: Now we’re very focused on TV shows and movies, and there’s an enormous opportunity. If you look at our selection, it’s really good. But it’s still a small part of the total universe of TV shows and movies. So both on the subscriber view and on the content view, we have tons of room to expand within TV shows and movies.

BI: On the selection issue, certainly with our family, what often happens is that we’ll start talking about watching a particular movie, everyone gets all excited, and the kids will say “Oh it’ll be on Netflix." Then they’ll go check and find out that it’s there via DVD, which is great, but suddenly it seems like Pony Express to wait for the DVD, and it’s often not there on streaming. How long will it take before most of the stuff that we’re all looking for is just going to be there, and it becomes relatively rare that you don’t have something available for streaming?

RH: Really, it is there today, from iTunes or Amazon, it’s just that you have to pay-per-view. So the newer stuff is first available in pay-per-view, and both of the services, iTunes and Amazon, are pretty comprehensive, but you’ve got to pay each time.

BI: Will you ever get into pay-per-view?

RH: Very, very unlikely. We’re focused on the subscription. Unlimited for a flat fee. That simple proposition. So the same answer I gave you about simple possibilities with tiering.

BI: Do you see Apple getting into a subscription thing at any point? There have been talks that they are, in theory, doing that, but we haven’t seen it yet.

RH: You’d have to ask them. Amazon is in subscription as you know with Prime, Hulu Plus is in subscription, and there may be others over time.

BI: But, really, why wouldn’t you offer pay-per-view? You now have this incredible catalog where you can find any movie and it’s either available by DVD or streaming--would it really muddy the waters that much to have a pay-per-view option?

RH: If you do sports news, you'd find that some of your readers really enjoy it, because you have a unique take on it, but that mostly it’s such a big competitive market that you really have to make your brand stand for something very specific. At least until you’re the size of the Wall Street Journal. And for us, it’s about brand clarity, and that we stand for $7.99 per month for unlimited streaming. That’s what we really want to focus on and we think that’s the optimal strategy. Rather than try to get into every possible thing that our subscribers also want, like should we sell DVDs? Should we offer various equipment? Etc etc.

BI: You guys are on a tremendous number of devices ranging from video game consoles to connected TVs and all that. Have you noticed anything unusual or interesting about the way people are consuming streaming content across any of these devices?

RH: It’s really quite broad. We get great traction on internet TVs, on Blu-ray players, on game consoles, iPads, Apple TV, iPhone. It’s amazing really how broad the viewing of our content is.

BI: Do you have any interest in the complementary social aspects that a lot of startups are focusing on? Getting people communicating on a second screen or even the first screen while they’re watching a show, or is Netflix kind of a private experience?

RH: We’re open to adapting our service as new enjoyment paradigms rise (such as multi-person viewing), so there’s social thing for finding content you want to watch, like these six other people you know just watched X, and then there’s social thing during the watching which is a little trickier with online because it’s asynchronous. Everyone watches at a different time. But, just as social transforms the internet generally, it will also transform the Netflix experience.

BI: So you just had to offer a higher compression streaming option in Canada because of bandwidth caps and overage charges, and I saw you talk quite a bit about this during the last earnings presentation. Do you think this is going to be a problem here in the states where we’re going to have to think about keeping an eye on the bandwidth meter, and do you foresee yourself having to adjust your service here to meet that?

RH: Well in ways we already have caps. If you look at most of the iPad mobile plans, they’re 2 GB, and then $10 per GB after that. AT&T just implemented an 150 GB cap on DSL, 250 GB on U-Verse fiber. So that’s clearly a move by some ISPs at least, and hopefully other ISPs will compete against them on the basis of being unlimited.

RH: With Google’s Kansas City move, hopefully that’s a sign of a long-term future trend that most of America gets Gigabit Ethernet, or Internet, and that these kind of skirmishes around 50 gigs, 100 gigs, 200 gigs are perceived to be like the 640K PC barrier 30 years ago.

BI: There seem to be people who think that MSOs [cable operators] and Telcos will try to stifle competition from people like you by imposing really small caps and high overage fees. Is that plausible or do you think that’s a worry that people shouldn’t have?

RH: No that’s plausible. In Canada, right after we announced that we were entering Canada, a few days after, Rogers lowered the caps on their most popular plans. So those kinds of things can definitely happen and then it’s an ongoing tension. We can do those high-density encodes like you referred to, and hopefully over time, broad, fast, inexpensive Internet becomes more and more a part of every person’s life, and that will open the possibility again over five or ten years for more online video.

NEXT: The increasing competition...

BI: That's a good segue into competition. This market is just incredibly noisy and there’s so much competition, you’ve got TV everywhere and you’ve got pay-per-view stuff, you’ve got Amazon now linking streaming to Prime, you’ve got Facebook suddenly doing a deal with Warner, Google TV, so forth. Who scares you?

RH: In the beginnings of a new market, it’s really hard to figure out who the long-term competition is, and what we tend to focus on is how to grow our business, and we’ll see what competition emerges. In general, the big incumbents, like the MVPDs, they may turn out to be the biggest competition with TV everywhere. But it depends on what their goals are and how they execute, and in particular, the more consumers see us as truly complementary, to MVPDs, then the less incentive they are to try to stop us or kill us.

BI: What percentage of the 100 million households that have cable and satellite do you think can actually afford a complementary service on top of the cable service?

BI: What do you think is the likely future of cable? A lot of people are saying “Look, there’s certainly a business for cable. Somebody’s got to be the actual hook-up to the Internet, but the idea that somebody else is going to have a box and control all the content is just ludicrous, and ultimately they [cable providers] will be reduced to being big fat pipes. Do you think that’s reasonable?

RH: No, that’s too pessimistic. They certainly will have a broadband business, which has very high profitability because it doesn’t have content costs. They’ll have a telephony business, and many, many more people get telephony from their cable company than they do from Vonage or Skype. Third, they’ll have a video business and they’ll offer unique content bundles, unique other things. I mean look at DirecTV—it’s growing substantially because it’s got incredible NFL content.

BI: On that subject--the sports question--are there folks who will do what Netflix has done in sports and become a very viable alternative option?

RH: Well there’s MLB TV which runs direct to consumer subscriptions today. So that would be a place to start, and then whether NFL and other leagues do the same I’m not sure. Certainly MLB is doing that to a degree today, and I think they try to keep it somewhat complementary. Out of season games, that kind of thing.

BI: Lastly, I have a couple questions about Netflix’s culture. I was fascinated by the presentation you did about that a couple of years ago. For example, the fact that you have no set vacation policy company-wide--that folks can take as much vacation as they want. When I broached that idea here asking if it was a good idea and if we should do that, people freaked out because they said “No, what’ll happen is everyone will work around the clock and I will feel like I can never take a vacation.” Why do you have the no vacation policy?

RH: I would say we don’t have a “no vacation” policy, that’s a little ambiguous. Instead, we have no policy on vacation. Perhaps because I take lots of great vacations it sets a good example. If you [Henry] were more visibly on vacation and then when you asked the question about it, everyone would probably relax. To the degree that you hardly ever are seen to take vacation, that might scare people.

RH: You’re over-simplifying with A’s and B’s. There’s a lot of graduations in terms of how someone performs. We’ve often had someone who was performing OK at one job so we move them to another job and they do fantastic. So it’s not even that much a reflection on the person. But in general, a sports-oriented model is “If you want to win the championships, you have to have great players who can work together.” You need both of those, and so that’s what we focus on: getting great people who can work together.

BI: How do you convey to somebody that they’re just not quite great enough?

RH: An employee who doesn’t work out usually knows it and the parting is mutual. Most admit they thought it would be for them and ignored signs that it wouldn’t. For example, we hire a lot of seasoned people but we don’t have all the perks – cubes, not offices, very few assistants, small staffs, no traditional HR support (plan your own offsite!). Some find that refreshing, others learn quickly that they’re accustomed to all the trappings and aren’t comfortable without them. It’s an honest and candid environment, and as a result, most employees who don’t work out say thank you when they leave. And severances are generous.

BI: Is there anything else that you think is critical to Netflix’s culture that has helped you become such an incredibly successful company over the past ten years?

RH: It’s like the classic example: Which of the innovations for the DC-10 were most important? The retractable flaps and retractable wings, they all went together, and it’s pretty hard to put a finger on it. Some of the things are symbols -- the vacation policy symbolizes freedom and responsibility. But you couldn’t really do freedom and responsibility without high performance. And so those are intimately linked. And you couldn’t do freedom and responsibility without our kind of context management model.

BI: Which is what?

RH: In our culture deck, there’s a chapter on “context, not control,” which is using your role as manager and leader to educate people and what we’re trying to do and not guiding each specific action a person takes. When someone working for you does something that you think is a bad choice, instead of blaming them, it’s reflecting on yourself in terms of what context you failed to provide. Such as finding a talented person, who would come to the right decision. So it’s always reflecting back on the manager--what context did I fail to set?

BI: Are there other key aspects of it?

RH: The values are really key, that not only should one be clear about one’s values, but that there’s a collective intolerance to bad behavior.

BI: Last thing… you wrote an extraordinary public letter to Whitney Tilson, who had publicly shorted your stock. When CEOs do that it’s usually a huge red flag and everybody in the world says “The company is screwed--I can pile on now.” Obviously you phrased the letter in a way that wasn’t like that at all. You went point by point. Yet, in the middle of it, you say that there are some things that Whitney was right to be concerned about. So what else should people actually be worried about?

RH: I’d refer you to our January earnings letter where we said the two core questions are: “Given our approach, how big will we get in the domestic market?” and second, “How successful will we be internationally?” Those are the two core investor questions.

BI: You never did actually answer the first question we asked about how big you’ll get domestically. How big will you get domestically?

RH: That’s exactly why there are investors who debate that. It doesn’t really matter what I think. It matters what actually happens.

BI: I know it doesn’t matter, but I’m interested. How big do you think you’ll get?

RH: There’s no simple way to tell it. We’re growing very well right now, and we’re focused on making our service better and better. But other than those benchmarks that I gave you, and then the question is “Well, what’s the appropriate discount to apply to those?” That’s where the investor judgment comes in. And then once an investor answers those questions for themselves, then they can figure out if they want to be a buyer of our stock at the current price.

BI: And what about the international question? Are there unique challenges in many of the other attractive markets where there is broadband and people that want to watch TV that will prevent you from being successful?

RH: Yes--in certain markets, in China in particular, it looks very daunting for US companies to build a profitable business.